Shareholder
On December 20, 2019, President Donald J. Trump signed the Setting Every Community Up for Retirement Enhancement Act of 2019 (“SECURE Act”) into law.
If you have a retirement account and/or if you anticipate being named as a beneficiary of a retirement account, here is a summary of what you need to know about the new rules and their limited exceptions.
The SECURE Act contains some new taxpayer-friendly provisions. If you are part of a retirement plan, you are now free to continue making contributions to the retirement plan at any age. You are no longer prohibited from making retirement contributions after age 70½. Also, under the pre-SECURE Act rules, you were required to begin taking required minimum distributions (thus paying income tax on those distributions) in the year following the year in which you turned 70½ years old. Under the new rules of the SECURE Act, that age changes to 72, so you are not required to begin taking required minimum distributions from your retirement accounts until the year following the year in which you turn age 72.
Now for some new not-so-taxpayer-friendly changes. It is estimated the SECURE Act will generate an additional $15.7 billion in tax revenue to the federal government. In large measure, this new tax revenue will be generated because the required time for the beneficiaries to take distributions after the death of an account owner has been drastically shortened. The few exceptions are described below. These changes apply only to retirement accounts of people who die after December 31, 2019.
But, before considering the changes, note that the rules concerning a surviving spouse have not changed: If a spouse is the beneficiary, after the account owner’s death the account can still be rolled over into an IRA owned by the surviving spouse.
For a beneficiary who is not a surviving spouse, the rules, with some exceptions, have changed dramatically. Under prior law, a beneficiary could elect to take required minimum distributions over his or her life expectancy pursuant to the IRS Table (the so-called “stretch rule”). In this way the stretch rule significantly enhanced the potential to defer income tax for retirement accounts, as taxpayers could obtain a huge extension of the tax-deferral period. The impact of the stretch rule could be further magnified if grandchildren were designated as beneficiaries. A similar result could be obtained by naming a See-Through Trust as the designated beneficiary of the account. The inherited account stretch rule was largely repealed by the SECURE Act.
The SECURE Act allows most beneficiaries a maximum deferral of 10 years. Unless one of the following four exceptions to this new rule applies, the entire balance of the account must be paid out within 10 years of the original account owner’s death. The SECURE Act provides these four exceptions to the new 10-year distribution requirement:
- A minor. The life expectancy payout method applies until the child reaches the age of majority (age 18 in Massachusetts), at which point the 10-year payout rule applies.
- A person with a disability which prevents him or her from being able to engage in any substantial gainful employment.
- A person who is certified as being chronically ill.
- A person who is less than 10 years younger than the retirement account owner.
- Under the prior law, if a trust was named as the beneficiary of a retirement account, the trust had to be a See-Through Trust to qualify for the stretch rule.
- Under the SECURE Act, to qualify for the payment within 10 years of an account owner’s death, a trust must also be a See-Through Trust.
- See-Through Trusts are either Conduit Trusts or Accumulation Trusts.
- For Conduit Trusts, the retirement account proceeds must be distributed to the trust’s conduit beneficiary(ies) when withdrawn from the retirement account. The trust may have estates and charities as remainder/contingent trust beneficiaries.
- For Accumulation Trusts, once distributed from the retirement account, the retirement account proceeds may remain in trust indefinitely, in accordance with the trust’s terms. The trust may not have an estate or a charity as a trust beneficiary.
- Other than Supplemental Needs Trusts, most trusts which were named as beneficiaries of retirement accounts under prior law were drafted as Conduit Trusts.
We believe that most of our clients with a trust named as beneficiary of their retirement accounts should replace the Conduit Trust provisions in their trusts with Accumulation Trust provisions. This is because under the new law, Conduit Trust provisions will require the entire retirement account to be distributed to the beneficiary within 10 years after the account owner’s death. Once distributed to the beneficiary, the retirement account funds are subject to attack by the beneficiary’s creditors, including a divorcing spouse, and are includible in the beneficiary’s own future estate for estate tax purposes. In contrast, the Accumulation Trust provisions would allow the retirement account proceeds to remain in trust – potentially for the beneficiary’s entire lifetime – thereby extending the creditor protection period and sheltering the retirement account balance from being included in the beneficiary’s taxable estate. Depending on the value of the retirement account, however, the Accumulation Trust could also cause the withdrawn retirement account proceeds remaining in trust to be subject to a higher income tax bracket.
A Supplemental Needs Trust is a trust established for a beneficiary who has a disability and may qualify for certain government benefits. As described above, (i) a person with a disability which prevents him or her from being able to engage in substantial gainful employment or (ii) a person who is certified as being chronically ill is not subject to the new 10-year maximum deferral but can take distributions over his or her life expectancy (the stretch rule). Similarly, if a Supplemental Needs Trust has been established for the benefit of such an individual, and that Supplemental Needs Trust is the beneficiary of a retirement account, the trust may take distributions over that individual’s life expectancy. To qualify for the stretch rule, the Supplemental Needs Trust must contain certain provisions and qualify as an Accumulation Trust. Supplemental Needs Trusts which were executed in 2017 or later already include the Accumulation Trust provisions. However, older Supplemental Needs Trusts and any Supplemental Needs Trusts which include one or more non-disabled person(s) as beneficiaries in addition to a disabled beneficiary should be amended to incorporate the appropriate Accumulation Trust provisions.
So, what does all this mean to you?
- Fortunately, for the purposes of the new 10-year payout requirement, the rules for determining how beneficiaries are designated do not come into play until the death of the original account holder. This reprieve provides you with an opportunity to reevaluate existing trust documents and ensure the tax language is consistent with the new rules and your estate planning objectives.
- If you have a trust – other than a Supplemental Needs Trust – which is named as the beneficiary of a retirement account, then you likely should amend that trust to insert the Accumulation Trust provisions.
- If only individuals are named as beneficiaries of your retirement accounts, then there is probably no need to update your estate plan.
- If your estate plan contains a Supplemental Needs Trust for a family member with a disability, it is likely that the SECURE Act will permit the life expectancy of the Supplemental Needs Trust beneficiary to govern the required minimum distributions, rather than the compressed 10-year payout rule. As described above, Supplemental Needs Trusts that are older or have multiple beneficiaries should be amended.
- If it appears that your estate plan is affected by the SECURE Act, or you are not sure, you should schedule an appointment with your estate planning attorney at Fletcher Tilton PC.